It is clear that government will have a hard time financing their deficits and capital investment programmes with gilts or at the least that if they do issue gilts on the scale necessary, gilt yields will have to rise by around 100 basis points.

As DB schemes now have negative cash flows, they will for choice be net sellers of gilts. Similarly, the Bank of England is a net seller of gilts as it winds down the £600 billion plus quantitative easing portfolio. Lastly, it is unreasonable to expect to be able to rely on the kindness of foreigners – approximately one third of the ‘foreign’ demand of recent decades actually came from LDI funds domiciled in Ireland and Luxembourg, which were of course owned by UK DB pension schemes.

There is no reason to believe that DC pension schemes will buy gilts at the levels seen by DB – there are no explicit liabilities to be hedged by some misconceived LDI strategy. This extends to CDC.

The effects of gilt issuance on the scale necessary to finance both deficits and the investment programmes of infrastructure and new towns will markedly further harm government finances and indeed growth.

We have proposed that much of the proposed capital investment can be achieved by Development Agencies with the power to borrow and the power to apply land value capture taxes. This would result in the issuance of 30-40 year Development Bonds at rates, we estimate, of around 100 basis points above gilt yields. This is a method of finance much utilised in Europe.

Additional comment from original source

It is important to recognise that the cost to the government of using Development Agencies rather than gilt issuance is lower overall than simply using gilts to finance the proposed New Towns and infrastructure investment. If financed by gilt issuance, the cost of gilts will rise by something close to or perhaps above 100 basis points. This will affect not just the cost of new issuance but also the cost of refinancing maturing gilts. In the case of the Bank of England’s holdings, the rise in yields will result in lower proceeds from the Bank’s sales and larger losses falling upon the Treasury.

If the Bank chooses to simply allow the portfolio holdings to mature, then the refinancing cost will be higher. The Development Agency bonds can be expected to have a minor effect on the levels of gilt yields – and perhaps none if the revenue raising powers of those Agencies are sufficient, and different from the revenue sources of HMT.

A very balanced article, Henry.

I have two observations:

DB pensions have their origin as an occupational pension providing deferred remuneration for the individual for the remainder of life after the retirement date set by the employer. I am old enough to remember employers keeping pensioners on the company payroll, at say half salary. Where funded, the employer funds the deferred remuneration on a collective basis respecting the life span of the pensioners, hence the attraction of long dated gilts to the employer sponsored DB pension fund.

DC pensions (formerly personal pensions) are in essence a saving vehicle for later life. Employers are merely paying a contracted payment into the individual’s savings pot, whether that is managed by the individual (e.g. a group personal pension) or by the pension provider (e.g. a mastertrust). Like all savings vehicles the individual has to consider the value of the savings pot on a regular basis. The individual has no certainty how long he will remain invested in that particular vehicle, e.g. change of employment, uncertain retirement age, better returns on an alternative investment, switch to decumulation etc. This makes the highly volatile long dated gilt less attractive to the DC pension fund.

Having said on that, as someone in their 70’s, in my own SIPP I have recently invested a proportion of my fund in the Treasury 2056 5 3/8th Gilt at a price just a fraction below par. This will give me an income for the remainder of my life (after administration costs) of say £100 per week for £100,000 invested. When I am over 100 I will then get slightly over £100,000 back to fund the remainder of my life or to add to my estate. The significance is that with the SIPP I am self investing and comfortable that I do not have to consider any time horizon shorter than my lifespan.

Following Peter’s comments, there is some discussion about the yield available to DC savers who want an alternative to annuities that contracts directly with the issuer – the Treasury. Lending the Government money means getting the money back + a contracted rate of interest for a chosen time frame. The discussion is over the conservative estimate of interest received and the canny Chair of Trustees has deducted the cost of the SIPP he has purchased.

There is no suggestion that most savers will follow Peter’s example, this is only a statement that this option is available. But at the micro level, Peter’s comments make it obvious why why gilts are helpful as a means to certain outcomes on a micro basis.

My other commentator gives me an economist’s perspective. Either way, we need to recognise that we are in danger of losing this relationship between Government, pensions and certainty. Gilts are at risk from annuities which threaten DB and DC pensions in different ways.

I hope that we will not hand over the remainder of our pensions to insurance –  to corporate bonds and private credit. I have heard the Bank of England, PRA and Treasury extol  de-risking of our retirement plans through insurance;  the economist and the pension trustee seem to be as one,  the loss of gilts is much greater .